DryShips Should See Another Rising Tide

The bulk carrier is consolidating its gains, and the technical setup points to a steady increase.
By Alan Farley ,

DryShips (DRYS) - Get Report had a fabulous run between the middle of 2006 and late 2007, benefiting from the historic surge in raw-material exports to Asia.

The powerful rally

ended in the fourth quarter when dry bulk shipping rates dropped suddenly, in response to anxiety that worldwide growth would stall because of the seizure in the credit markets.

Dry bulk rates have come storming back in 2008, allowing the entire to sector lift off deep lows and start a fresh run at the all-time highs posted last year.

DryShips is now trading in the dead center the broad range established by its deep correction. This raises the question, can the recovery rally continue or will it give way to another down leg?

DryShips in a Range

Click here for larger image.

Source: eSignal

The company came public in early 2005 at just above $21 and entered a downtrend that dropped price into single digits by the middle of 2006. It bottomed out at $8.50 and turned immediately into its long rally run. The stock rose over 600% in the next 18 months, making it one of the top performers in 2007.

The broad rally carved out just two consolidation patterns. The first one yielded a small rectangle lasting about six weeks, and the second corresponded to high market volatility last August. The choppy range during that period gave way to a parabola that covered 80 points in less than 10 weeks, before stalling at the October top.

A vertical rally is a precursor to a deep correction, because this type of price action is unsustainable. Invariably, it generates instability that can be resolved only through a selloff that shakes out the majority of folks who were sucked into the euphoria. It was certainly no different this time around, with DryShips collapsing into the January low.

The decline ended at the 62% rally retracement, which marks a common price zone for the start of a measured recovery. The first bounce stalled at 38%, yet another Fibonacci retracement, setting up ping-pong action that lasted through the first quarter. Things have calmed down considerably since then, with price moving higher in a steady buying wave.

DryShips' Waves

Click here for larger image.

Source: eSignal

Let's examine price action since the October high in more detail. The decline shows two distinct selling waves, with a choppy recovery in November and December. This is generally bullish, because corrections from healthy bull advances tend to show a-b-c patterns, like this one, rather than five-wave declines, with three major selling waves.

A rally often resumes and takes out the old high after the completion of the "c" leg of the selloff, which in this case took place between December and January. However, other charting features suggest that the recovery attempt is approaching a major barrier that will take time to overcome.

The size of the post-January bounce now equals the size of the post-March bounce. In technical terms, this marks out a measured move target that completes an expected price swing. Notably, the stock just rallied through the 50% retracement of the October-January selloff, with the round number $100 converging at the 62% retracement level.

The combination of measured move target, round number and Fibonacci resistance point to the end of the rally wave off the March low and the start of another pullback. Notably, the 50-day and 200-day moving averages are sitting between $71 and $77. These support levels should limit any decline and set up a "second chance" buying opportunity.

Despite expected headwinds in the next few weeks, other technical factors support a full recovery in the third and fourth quarter. Take a look at the interplay between the 50-day and 200-day moving averages in the last few months. Note how the 50-day dropped down to the 200-day in April, tagged it, rounded the corner and then moved higher.

This graceful movement points to underlying support that should keep price well off this year's lows. If you flip through the charts of stocks that bounced in the first quarter after deep selloffs, you'll find just a handful in which the 50-day MA failed to cross under the 200-day MA. So this points to hidden strength that will support the stock going forward.

Buying interest has been rock-solid since the March low. This is good and bad, because price actually bottomed in January. Notice how on-balance volume undercut the January low in March, even though price stayed above that level. This adds a measure of delay into the recovery math, predicting that the stock needs more consolidation before returning to the 2007 high.

So things are looking up for DryShips, but this analysis will still annoy a few shareholders. I've been criticized for insinuating that it's normal behavior for good-looking stocks to pull back in order to consolidate their gains. It seems that a few marginal players expect their pet stocks to go up every single day because, you know, that's the way it works.

In reality, back-and-fill price action is a market dynamic that forces patience, shakes out weak hands and encourages sidelined capital to enter new positions. And it's exactly what a fallen market leader, like DryShips, needs to do right now to set up more supportive conditions for a run to new highs later this year.

Alan Farley provides daily stock picks and commentary with his "Daily Swing Trade" newsletter.

At the time of publication, Farley had no positions, although holdings can change at any time.

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